New Zealand electricity market marred by uncertainty

June 13, 2013 | 00:00

No one predicted the cloud of uncertainty that shrouds the New Zealand’s electricity sector in May 2013. Just as the centre-right Government forges ahead with the so-called partial privatisation of three state-owned generator-retailers, opposition parties have revealed plans to scrap the wholesale electricity market in favour of a centrally...

New Zealand electricity market marred by uncertainty

Edward White

No one predicted the cloud of uncertainty that shrouds the New Zealand’s electricity sector in May 2013. Just as the centre-right Government forges ahead with the so-called partial privatisation of three state-owned generator-retailers, opposition parties have revealed plans to scrap the wholesale electricity market in favour of a centrally controlled, single-buyer regime.

Turbine blade about to be lifted in place at wind farm Te Uku, New Zealand (2010) (c) Meridian Energy

The future of many aspects of the electricity sector was, at best, already opaque: industrial demand is seriously under threat; price controls for electricity distribution is subject to a merits review in the High Court; the fledgling industry regulator is eyeing big changes to how transmission costs are allocated; and the two major political factions have entirely different ambitions for the carbon market.

Then, as one market analyst said, on April 18 the ‘policy hand grenade’ was thrown by the heir-apparent Labour-Green parties, sending shockwaves through the industry; the afternoon it was announced, several hundred million dollars was wiped off the value of the few listed players. The proposal would essentially see New Zealand return to the system it had in the early 1990s; central control over power dispatch, wholesale electricity prices and generation investment decisions. It might also require the country’s five vertically integrated ‘gentailers’ – who dominate the market – to separate their generation and retail business.

Industry warns

The Government has labelled the policy and the parties behind it as extreme and far-left. Industry players and the investment community, fresh from a softer phase of reform in 2010, are warning of dire consequences for future investment in New Zealand. But, as the politicians keep saying, retail electricity prices have risen sharply in the past decade and the affordability of such a basic service is of increasing concern to many. Given, therefore, the mainstream appeal that a promise of lower power bills holds, not to mention Labour and the Greens are consistently polling above the National-led Government, it remains a definite possibility that the proposal could become law if the parties are elected to govern in late 2014.

Still, it should be remembered, that implementation would not be likely for several years; the process of untangling the current market and its long-term supply arrangements, and of course establishing a whole new system would both be fraught with difficulty, and likely subject to legal action.

Aside from the threat of political influence, the sector is battling several long-term structural challenges. In the years leading into the global financial crisis,

The ‘policy hand grenade’ was thrown by the heir-apparent Labour-Green parties, sending shockwaves through the industry

economic growth helped mask the continued hollowing out of manufacturing in New Zealand. Since the crash, the general downturn – indeed recession – has been coupled with major industrials, including big pulp and paper manufacturers Norske Skog and SCA Hygiene, cutting back production. Low demand growth has not been helped by a bullish phase of generation building that has seen a handful of geothermal plants and wind farms built in the past few years. The subsequent oversupply of generation capacity looks set to dampen the market for the medium-term at least.

The supply-demand balance has not been helped this year; the closure of the Rio Tinto-owned aluminium smelter, the country’s biggest power user accounting for about 15 per cent of the country’s annual load, has emerged as a serious threat. Meridian Energy, the country’s biggest generator – and likely to have shares listed on the stock exchange in October – has a financial contract with the smelter’s operating company, New Zealand Aluminium Smelter, guaranteeing price certainty for most of the smelter's load. The company’s 854 MW Manapouri dam, commissioned in 1972, was built to supply the smelter. Rio’s Pacific Aluminium unit is currently trying to renegotiate Tiwai’s 18-year contract. The contract was settled in October 2007 after almost three years of negotiations, and came into force from January 1 this year.

According to one market analyst, the logical path for Pacific Aluminium is to operate the plant through an initial two year ‘take-or-pay’ period, before making a final decision towards the end of 2015. Taking into account substantial closure costs – estimated in the hundreds of millions – and the loss of optionality that closure would mean to Rio, the analyst put the chance of the smelter closing in the medium-term at less than 50 per cent.

However, if the smelter does shutdown, and subsequently force a massive oversupply of cheap hydro generation, the market adjustment is likely to be swift. Analysts predict the country’s slow-start thermal generators would quickly shutdown or, where possible, be converted to peaking capacity – a process which has in fact already begun. Therefore, the impact on electricity prices, wholesale or retail, may not be quite as sharp, nor long-lived as one might expect from 15 per cent of the country’s load disappearing. Regardless of the outcome, having a question mark hanging over such a large chunk of the country’s load does nothing for market confidence.

Aside from the threat of political influence, the sector is battling several long-term structural challenges

Meanwhile, a new industry regulator, is trying to rewrite the playbook on how the country foots the soon-to-be almost NZD $1 billion annual bill for the country’s transmission interconnection and HVDC assets. Allocating transmission costs has long been a contentious exercise. The current effort is the fourth overseen by the Electricity Authority, or predecessor, the Electricity Commission, since 2009.

The regulator has proposed significant changes to the regime. The current scheme sees: connection charges paid by generators, distributors and large users; inter-island HVDC charges – most of New Zealand’s generation flows from the hydro generators in the South Island to the North Island – are paid by the South Island generators according to their share of historical peak injection to the grid; interconnection charges are mainly met by distributors and large consumers directly connected to the national grid. The proposed new system would allocate inter-island transmission and interconnection costs based on the actual benefits derived by the various parties. It would use the market's existing scheduling, pricing and dispatch model to determine that allocation on a half-hourly basis.

The wholesale nature of the proposed changes – and of course the fact that some parties, namely North Island generators, will face a much higher share of the bill than they currently do– has seen the proposal face some tough criticism. Of the more than 50 submissions received, almost all opposed the plan and the few submissions in support were heavily caveated. Whatever the direction the regulator choses to take next, it has said that implementation would not happen before 2016. It seems likely that the pricing methodology will go through further iterations before that time.

Despite the raft of aforementioned major issues, fundamentally, the New Zealand electricity sector remains in an enviable position compared to much of the world. A hydro-dominated electricity generation fleet, with a growing contribution from geothermal and, to a lesser extent, wind sees most of the country’s electricity supplied from renewable sources. Gas-fired plants are still key to secure supply, but increasingly their role is shifting from baseload to peaking – a natural match for intermittent renewables. The country’s ageing four coal-fired units, handily based just south of the country’s biggest city Auckland, are finding themselves surplus to requirements and have started to be retired, reducing the sector’s carbon footprint further.

The impetus on the demand-side is also being finally being seen at the consumer end of the spectrum

Better still for the country’s all-important ‘green’ credentials, geothermal and wind have emerged as the lowest-cost generation sources and will most likely be developed when more generation is required in the future. It should also be noted, that these sources are the first cab-off-the-rank without subsidies or incentives.

Focus on consumers

The security of electricity supply is looking good, too. State-owned Transpower is in the final throws of a seven-year $5 billion spend upgrading the national grid, including a once in a generation boosting of capacity on the inter-island link, and securing the future supply of power into Auckland. Though murmurings of ‘gold plating ‘and ‘overbuild’ can be heard, the grid operator is shifting its focus to demand-side response as a way to defer future transmission spends.

The impetus on the demand-side is also being finally being seen at the consumer end of the spectrum. The major players have been criticised for their glacial take-up of innovation – for example, online billing has only been actively promoted by some companies in the last couple of years. Advanced meters, albeit with pretty basic functionality, have now been deployed to about half the country’s households and businesses. While the ‘smart houses’ and ‘home area networks’ are still things of tomorrow, retailers are starting to provide customers with energy monitoring platforms. These offerings will allow mass-market customers see when power has been used, compare usage against previous periods or other nearby households, forecast monthly bills, set monthly budgets and receive alerts when they are tracking to exceed that budget. Also, different pricing options, including separate tariffs for day and night and for weekends, look set to be offered by most of the major players to the mass-market over the next 12 months.

Those initiatives, coupled with an improving hedge market, generation oversupply, low demand growth and greater retail competition should deliver a fairly subdued pricing environment for consumers over the next few years. Importantly for low-income households, a government programme that funds insulation for older homes, has already seen around 200,000 houses insulated, was this month extended.